Central America’s Interrupted Integration Intent
The arrival of hundreds of thousands monthly into the US and Mexico from the Northern Triangle of El Salvador, Guatemala, Honduras and the rest of Central America over the past year is an economic, diplomatic and humanitarian tragedy and specific investor disappointment. Latin America sovereign bond investors entered originally with a dedicated index. Equities joined corporate bonds on stock exchanges, with Panama recently added to the Morgan Stanley Capital International frontier list. Performance suffered amid fiscal and balance of payments woes, crime and insecurity, and lack of competiveness and policy reform after initial enthusiasm following passage of the Dominican Republic-Central American Free Trade Agreement (DR-CAFTA).
Regional banking and capital market integration blueprints were considered but never fully realized, amid notable strides in private pension creation and financial sector regulation. International development institutions and private fund managers offered encouragement and technical support, but focus disappeared long before the refugee and rule of law crises. In the US, the Obama Administration led a broad initiative to improve governance, and before cutting aid President Trump repeated that approach. The new Development Finance Corporation may revisit financial market building with venture capital deals, but the bigger agenda is missing to channel portfolio and remittance inflows.
El Salvador after its civil war had reconstruction and modernization as priorities in line with international standards. The central bank, working with the donors, invited bankers and fund managers to share best practices and recommendations for active credit and securities markets Officials committed to Basel Committee capital adequacy guidelines and diversifying beyond private debt placement. The exchange rate regime provided stability as a dollar peg and then the dollar outright was adopted. The ex-rebel FMLN and conservative ARENA parties alternated in power and promoted manufacturing exports to boost the balance of payments.
They introduced private pension funds as a main institutional investor and regular domestic and external bond buyer, However public debt now over 70% of gross domestic product is a drag on the economy projected to grow 2% this year, and it jeopardized the core social security system as benefits were delayed. The new President, former San Salvador mayor Nayib Bukele, took office in June after a landslide victory and promised to clean up the mess through “market-friendly” methods. He campaigned on increased social spending within a 3% fiscal deficit, and fresh funding alternatives to lift domestic demand, which could include a second generation private retirement contribution scheme.
Guatemala and Honduras are smaller in frontier bond markets, with lower debt levels and more commodities dependence. Honduras’ debut issue several years ago coincided with a fight over presidential removal for corruption, as dueling chief executives laid claim before snap elections. It previously received debt relief from bilateral and multilateral lenders under the low-income Heavily Indebted Poor Country program, mirroring a commercial access path more common in Africa.
While the Northern Triangle has pronounced “junk” credit ratings, the Dominican Republic, a small component in JP Morgan’s bond benchmarks, is BB and Panama is investment-grade BBB. Both register faster 5% growth, and have enacted tax and spending changes for greater budget balance. Before its recent tourism scare with unexplained visitor deaths the DR was a rare buy recommendation. Remittances combined with foreign residential and hotel investment for a minimal 1.5% of GDP current account gap, and President Danilo Medina in his second term backs public-private partnerships to remedy chronic electricity shortage. Panama received ratings upgrades the past year, with the incoming Cortizo government intent on combatting corruption and expanding mining and financial services to offset Canal revenue decline. It was a top MSCI performer in the first half, with a near 25% gain.
Central America’s positive economic and financial sector elements that once comprised the DR-CAFTA spirit have been forgotten with the current migration and security pressures and cross-border business and political recriminations. Bank and broker associations and chambers of commerce can reprise credit and capital market strengthening advocacy, as dedicated multilateral lenders like the Inter-American Development Bank and Andean Development Corporation (CAF) emphasize these themes within good governance and sustainable investment priorities. The CAF held an annual conference in Washington last week, and speakers cited hemispheric displacement and social and physical infrastructure crises new bond issues and indices and investor outreach policies could help overcome.